Financial Market
Derivatives Market – Forward & Futures
Financial Market
Derivatives Market – Forward & Futures
BUYER
SELLER
Participans:
The deal:
For a specific period of time
BUYER
will have an
OBLIGATION to buy
some
underling security for a price specified today.
Forward
’s features:
gives an obligation to buy (buyer
–
long position
) or to sell
(seller
–
short position
) of a particular security at price specified in contract.
WRITER
has an
OBLIGATION to deliver
the underlying security.
Strike (Exercise price) (K) = price at which the underlying transaction will occur upon exercise.
Expiration date / Settlement date (Maturity) (T) = the day when the forward expiry.
Multiplier (N) = the quantity of the underlying asset.
Underlying security = what security is going to be traded.
FORWARD CONTRACT
=
Financial Market
Derivatives Market - Forward
Today
Maturity
Buyer
and
seller
specify a
contract details.
Buyer
must buy,
Seller
must sell
underlying security at priced specified before.
Example 1:
A is signing a contract with B specifying that in December he will buy 10 Christmas trees
paying 100$ per tree.
Today
December
A
commits to buy 10 Christmas
trees from
B
in December.
A must
buy 10 Christmas trees.
B must
sell 10 Christmas trees.
Financial Market
Derivatives Market - Forward
Data from example 1:
What the
buyer
is about to do at maturity ?
Underlying security = Christmas Tree
N = 10
T = December
K = 100$
Let’s assume that Christmas tree price in December is going to be:
a) S
T
= 150$
b) S
T
= 120$
e) S
T
= 100$
c) S
T
= 80$
d) S
T
= 50$
Even thought the current Christmas tree price is higher, the
buyer will buy
it
for 100$
. His profit will be equal to
a) 50$
or
b) 20$ per tree
if he will sell the Christmas tree at the market immediately.
Totally he will
earn
to
a) 500$
or
b) 200$
.
Even thought the current Christmas tree price is lower, the
buyer will have to
buy
it
for 100$
. He will
lose c) 20$
or
d) 50$ per tree
if he will sell the
Christmas tree at the market immediately. Totally he will
lose c) 200$
or
d) 500$
.
Buyer won’t make any profit or loss.
Financial Market
Derivatives Market - Forward
Forward
’s
buyer
profit function:
K
0
S
T
Profit
In general:
100$
0
S
T
Profit
Data from example 1 (K = 100$, N = 10):
150$
200$
50$
500$
1000$
S
T
– K
Profit function for a
buyer
of a forward =
- 500$
Financial Market
Derivatives Market - Forward
Data from example 1:
What the
seller
is about to do at maturity ?
Underlying security = Christmas tree
N = 10
T = December
K = 100$
Let’s assume that Christmas tree price after T is going to be:
a) S
T
= 150$
b) S
T
= 120$
e) S
T
= 100$
c) S
T
= 80$
d) S
T
= 50$
Even thought the current Christmas tree price is higher, the
seller must sell
it
for
100$
. If the seller doesn
’t own 10 Christmas trees, he needs to buy them from the
market and then sell it to the forward
’s buyer. He will
lose a) 50$
or
b) 20$
per
tree. Totally seller will
lose a) 500$
or
b) 200$.
Even thought the current Christmas tree price is lower, the
seller will sell
it
for
100$
. If the seller doesn
’t own 10 Christmas trees, he needs to buy them from the
market and then sell it to the forward
’s buyer. He will
gain c) 20$
or
d) 50$
per
tree. Totally seller will
gain a) 500$
or
b) 200$.
Seller
won’t make any profit or loss.
Financial Market
Derivatives Market - Forward
K
0
S
T
100$
0
S
T
150$
200$
50$
500$
1000$
K
– S
T
80$
200$
Profit
In general:
Profit
Data from example 1 (K = 100$, N = 10):
Forward
’s
seller
profit function:
Profit function for a
seller
of a forward =
500$
Financial Market
Derivatives Market - Forward
Long vs Short position:
0
S
T
$
K
Financial Market
Derivatives Market - Forward
Futures contract = standardized forward contract.
BUYER
SELLER
Setting contract specification
specifies Futures parameters:
Underlying securities
Quantity
Settlement date
Takes deafault risk
Clears transaction
Financial Market
Derivatives Market - Futures
Indices:
WIG20:
FW20xx
Stocks:
TPSA:
FTPSxx
PKN :
FPKNxx
Currencies:
Euro:
FEURxx
USD:
FUSDxx
F
W20
Z
12
Futures
Underlying instrument sybmol
Maturity:
Month
,
Year
F: January
G: February
H: March
J: April
K: Mai
M: June
V: October
X: November
Z: December
N: July
Q: August
U: September
Examples:
Financial Market
Derivatives Market - Futures
Warsaw Stock Exchange (Friday, 26 XI 2010)
Multiplier: 10
Multiplier: 10 000
Multiplier: 100
Financial Market
Derivatives Market - Futures
Financial Market
Derivatives Market - Backwardation
Backwardation
(normal futures yield)
Financial Market
Derivatives Market - Contango
Contango
(inverted futures yield)
Financial Market
Derivatives Market - Backwardation & Contango
From Backwardation to Contango
Financial Market
Derivatives Market - Backwardation & Contango
How clearing companies maintain the default risk ??
1. Both sides must provide
Initial Margin
SELLER
BUYER
Buyer’s Account
Seller’s Account
Let’s assume TVN stock market price is 9 zł.
FTVNZ13 price is 10
zł (N = 100). Initial margin for TVN stock futures contracts is 15,00%.
Futures price * multiplier * initial margin level * number of contracts =
Initial margin =
= 10 * 100 * 15,00% * 1 = 150
zł
150
zł
150
zł
Financial Market
Derivatives Market - Futures
2. Daily Profit/Loss has to be
paid in cash
by participants (
from Initial Margin
)
When the underlying security price changes rapidly,
initial margin might be not enough to prevent default risk:
SELLER
BUYER
Buyer’s Account
Seller’s Account
Let’s assume that the price of FTVNZ13 raises from 10.00 zł to 10.50 zł at closing.
150
zł
150
zł
50
zł
25
zł
275
zł
The next day FTVNZ13 futures price raises from 10.50
zł to 11.25 zł.
75
zł
100
zł
200
zł
If the price of FTVNZ13 will continue to raise, seller
won’t be able to pay the buyer.
Financial Market
Derivatives Market - Futures
Futures price * multiplier * maintenance margin level * number of contracts =
Maintenance margin =
= 10 * 100 * 10,00% * 1 =
100
zł
Because the futures price can change rapidly until maturity,
clearing companies came up with idea of
maintenance margin
.
Maintenance margin
is just the amount of money, our account cannot go below.
If it will, we are required to refill our account
to the level of initial margin
.
Let’s assume TVN stock market price is 9 zł.
FTVNZ13 price is 10
zł (N = 100).
Initial margin
for TVN stock futures contracts is
15,00%
,
maintenance margin
is
10,00%
.
Initial margin =
10 * 100 * 15,00% * 1 =
150
zł
Financial Market
Derivatives Market - Futures
SELLER
BUYER
Buyer’s Account
Seller’s Account
25
0 zł
150
zł
1. FW20Z11 = 10
zł,
Margins: Initial: 15,00%, Maintenance: 10,00%
2. FW20Z11 = 11
zł,
100 zł
5
0 zł
150
zł
Seller account is below maintenance margin (50
zł < 110 zł).
11
5 zł
16
5 zł
3. FW20Z11 = 11.30
zł,
3
0 zł
135
zł
280
zł
Margins:
Initial: 150
zł,
Maintenance: 100
zł
Margins:
Initial: 165
zł,
Maintenance: 110
zł
It needs to be refill to initial margin level (165
zł).
Maintenance: 113
zł
Margins:
Financial Market
Derivatives Market - Futures
Market
Exchange
OTC
Standardization
Standardized
Negotiable
Risk
Taken by clearinghouse
Default risk
Settlement
Marking to market
At delivery
Initial margin
Yes
No
FUTURES
FORWARD
Financial Market
Derivatives Market – Forward vs Futures